Mezzanine and subordinated debt

Mezzanine can fill a financing gap after a senior lender reaches its risk limit but before the buyer has supplied all the required equity. It is still debt: it must ultimately be repaid under agreed terms. It generally ranks behind the senior lender, so a weak exit value can impair the mezzanine claim while the senior lender is still covered. The extra risk explains why a mezzanine investor may seek more than ordinary senior-loan interest. Read the Fund Launch guide

Fund Launch describes three possible return pieces: cash interest, interest added to the outstanding claim instead of paid now (PIK), and warrants or a similar equity participation. A buyer may welcome lower near-term cash payments from PIK, but the balance grows and the refinancing or exit must cover it. A warrant can reduce immediate cash cost while sharing upside with the capital provider. These pieces are negotiated; none is guaranteed to appear in every mezzanine loan.

Illustrative mechanism, not a market quote. Suppose a borrower owes $1 million of junior principal and $80,000 of interest is capitalized rather than paid in year one. The junior claim becomes $1.08 million before later interest or repayment. The $80,000 of cash relief this year creates a larger future obligation. Whether the company can refinance that obligation depends on its later performance and lender terms, not on the accounting entry.

Ranking is written into the documents

The senior and junior creditors may negotiate which payments are permitted, when the junior lender must pause enforcement, whether it can cure a senior default, and who controls a restructuring. The phrase “behind the bank” does not answer those questions. Sey’s acquisition closing example included a seller subordination deed. That demonstrates creditor ranking in a real reported closing account, but it does not establish that the seller held an institutional mezzanine product. Fund Launch supplies the product explanation, not evidence about that transaction. Read the Fund Launch guide Watch source

The lender’s view is different from the buyer’s: a mezzanine fund weighs its place in the stack, the senior lender’s rights, sponsor quality, borrower leverage, possible equity upside and prospects for exit or refinancing. Its covenants and enforcement rights must work around the senior lender’s priority. LPs must understand how much return is collected in cash and how much depends on accrued interest or warrant realizations. Portfolio concentration makes a single failed buyout consequential.

Where it sits

In a deal using separate tranches, a simplified order is senior debt → mezzanine or other subordinated debt → preferred equity if issued → common equity. Seller debt can occupy a negotiated junior position too, but its ranking is document-specific. A unitranche may replace separate senior and mezzanine facilities with one borrower-facing loan; it should not automatically be drawn as another layer in every stack. The actual payment and security priority controls. Read the Fund Launch direct-lending guide

Follow the connections

Subordination · Senior debt · Direct lending · Capital stack.

Continue in the course: Building the capital stack.